Shanghai FTZ moves gingerly to liberalize yuan

The Shanghai Free Trade Zone (FTZ) gained more access to offshore yuan on Friday as China cautiously moves to achieve the free flow of its currency.

The People's Bank of China (PBOC) revealed details of trans-border yuan regulations in the zone. Companies set up there can now borrow offshore yuan without previous restraints.

The Bank of Communications Financial Leasing (BCFL) has obtained a 700-million yuan (115-million U.S. dollars) loan from Bank of Communications Singapore via BCFL's branch in the zone. While lending rates in the Chinese mainland remain above six percent, offshore yuan borrowers pay less than four percent interest.

The Chinese financial market experienced three credit crunches last year with interbank rates shooting up double digits at one point.

Some analysts are concerned monetary tightening, which may re-appear this year as regulators seek to tackle overcapacity and surging government debt could squeeze the funding pipelines and raise borrowing costs.

Despite the prudent pace, the latest reform is expected to reduce borrowing costs in the FTZ, easing companies' financing burdens.

"Expanding trans-border use of the yuan in the Shanghai Free Trade Zone will push forward trans-border yuan business to a higher level," said Ling Tao, deputy director of PBoC Shanghai head office.

Tu Guangshao, deputy mayor of Shanghai, said the move would accelerate the yuan's pace to go global and help Shanghai become the world's center for pricing and settlement of yuan-denominated products.

According to regulations, borrowing should be used for companies' operations in the FTZ or abroad rather than for speculative trading.

"It demonstrates the regulators aim to prevent currency and interest arbitrage," said Zhang Xinyuan, general manager of the international settlements arm of the Bank of China.

However, the aggressive separate-account arrangement has not been included in the package.

The arrangement will not be launched before the country's annual parliamentary meeting, which begins in early March, according to sources close to the regulators.

The central bank has told commercial banks to continually test the arrangement, and carry it out only after the system is fully reliable, said a market insider working for a state-owned bank.

Personal capital account receipts and payments were also excluded from the details. But analysts said the measures should not be labeled "conservative", since regulators may consider such policies in a systemic way and any policy implemented in the zone is expected to be rolled out nationwide and thus requires more deliberation.

The central bank will also unveil detailed measures against money trafficking and the financing of terrorism, suggesting Chinese regulators keep vigilant to risks arising from financial liberalization.

Opening the capital account, a crucial step of liberalizing China's financial system, is the most debated economic reform.

China re-started to free its currency exchange rate in 2005, and since then the Chinese yuan has appreciated over 30 percent against the U.S. dollar.

But to buffer China from international financial turmoil, the country's capital account remains closed, a rule in existence for decades.

Exchanges between the Chinese yuan and foreign currencies are regulated with strict quota allocation and transactions are scrutinized. Every Chinese person is only allowed to buy up to 50,000 U.S. dollars each year.

While some believe tearing down the currency wall can improve financial transparency and efficiency as well as spur China's drive of building Shanghai into a world financial hub, others argue opening the capital account now would expose the country to more overseas volatility and add to risks already rising from runaway shadow banking and fast accumulation of debt.

The United States Federal Reserve is poised to reduce its bond-buying program by another 10 billion U.S. dollars a month. Jitters over the Fed's QE tapering have spawned a broad sell off in emerging economies, reeling the capital markets in Turkey and Argentina and plunging currencies of several "star" developing economies.

Economists say it is the closed capital account that kept China immune to the QE tapering while other emerging economies saw their asset prices and currency exchange rates dive.

It is feared that demolishing the currency curb may trigger a capital flight as China's economic growth is expected to dip further after hitting the lowest level since 1999.

The Shanghai FTZ was launched at a time when China is tackling challenges that have emerged from its upgrade to a more value-added and consumption-driven model. It is viewed as a test bed for China's drive of deepening market-oriented reforms and boosting economic vitality.

The FTZ is built to seek institutional arrangements that can be copied and rolled out nationwide, according to Jian Danian, deputy director of the FTZ's managing committee.